Knowing and Making

Paul Krugman (quoting Jan Hatzius) uncovers another scary article from another Fed president: Third, the statement seems to be at odds with a recent article by President Bullard of St. Louis suggesting that a continuation of the Fed’s current stance on short-term interest rates could result in deflation (see “Seven Faces of ‘The Peril’”, July 28, 2010). The first sentence of the abstract reads: “In this paper I discuss the possibility that the U.S. economy may become enmeshed in a Japanese-style, deflationary outcome within the next several years.” The original report from Bullard can be found here . Guess who is thanked in the footer of page 1? Narayana Kocherlakota (as well as David Andolfatto, regular blog commentator on Worthwhile Canadian Initiative and TheMoneyIllusion ). So what's going on? The paper is making the same argument for which Kocherlakota has been pilloried over the last two weeks. But the paradoxes in that paper are layered with yet more contradictions: H...

Turns out quantitative easing is  deflationary - at least the Federal Reserve thinks so. Today the Fed announced that the interest and capital repayments from the bonds it bought last year will not be retired from the system (which would reduce the money supply). Instead, they will use them to buy new Treasury bonds. Via Mark Thoma: ...the Fed will keep “securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities” Now I hate to say I told you so, but I told you so ... There is, however, a point more important than my self-satisfaction: whether this policy will work. Unfortunately this policy adjustment appears to reveal a basic uncertainty in the Fed's goals. By making ad hoc adjustments like this, the Fed keeps the rest of us off balance - we don't know what it will do next because its signals are too vague. In some cases this kind of policy is desirable - regulators and...

Here's  a little something  on fiscal stimulus. It contains a suggestion I've seen from Tyler Cowen and Scott Sumner, among others: ...while the zero bound does not bind, the Fed might nonetheless be reluctant to engage in the appropriate amount of monetary expansion, and that a fiscal boost is therefore required. A potential response to this is that if the Fed has chosen the unemployment rate with which it is satisfied, it will simply offset any fiscal measures to push unemployment below that level. That's only true if the Fed is assumed to be a simple (rational?) agent acting with just one lever: controlling the money supply in order to choose a balance between inflation and unemployment. However, it's very plausible that the Fed is  not  happy about the current unemployment rate, and recognises that it could and perhaps should increase inflation (or NGDP) to fight it. But it is  also  worried about its long-term credibility (as Ben Bernanke indicates i...

Pointing out a speech by William C. Dudley, president of the New York Fed, Simon Johnson says : Dudley says that the Fed can pop or prevent asset bubbles from developing. This would represent a major change in the nature of American (and G7) central banking. It’s a huge statement - throwing the Greenspan years out of the door, without ceremony. It’s also an attractive idea. But how will the Fed actually implement? Senior Fed officials in 2007 and 2008 were quite clear that there is no technology that would allow them to "sniff" bubbles accurately - and this was in the face of a housing bubble that, in retrospect, Dudley says was obvious. But is that true? If we define a bubble as "overvaluation of assets relative to their future returns" then to spot one, we would need to compare asset prices with future returns. But although asset prices are measurable, future returns are not - and this is why people generally think that bubbles are unspottable. We wouldn't...